multinationalfinance-chap8

multinationalfinance-chap8 - 8. Definitions of Foreign 8....

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Unformatted text preview: 8. Definitions of Foreign 8. Exchange risk Exchange There are three forms of currency risk: transaction exposure, translation exposure and economic exposure. Dr. Yinghong Chen Skövde University Dr. Yinghong Chen Sk 1 Foreign Exchange risk Foreign exchange risk concerns risks created by changes in foreign currency levels Exposure arises because currency movements may alter home currency values of an foreign subsidiary’s accounts: balance sheet and income statements. 2 Dr. Yinghong Chen Skövde University The definitions of the three The exposures exposures Transaction exposure arises because a payable or Transaction receivable is denominated in a foreign currency. receivable Translation exposure (accounting exposure) arises Translation when consolidating foreign-currency-denominated assets, liabilities and profits. Economic exposure arises because the present value Economic of a stream of expected future operating cash flows denominated in the home currency or in a foreign currency may vary because of changed exchange rates. The law of consolidation of all subsidiaries applies to ownership exceeding 20%+ by parent company ownership 3 Dr. Yinghong Chen Skövde University Channels of Economic Channels Exposure Exposure Asset exposure Home currency value of assets and liabilities Exchange rate fluctuations Operating exposure Firm Value Future operating cash flows 4 Dr. Yinghong Chen Skövde University Translation/accounting exposure Translation/accounting are not cash flow based are The magnitude of a translation exposure varies The according to the accounting convention used for translation of foreign-denominated items. Four basic translation methods. 1. The current/non-current method 1. 2. The all current (closing rate) method 3. The monetary/non-monetary method 4. The temporal method. The Currently all current (closing rate) method is used by major countries in the world. major 5 Dr. Yinghong Chen Skövde University Translation/accounting exposure: The current/non-current method: The accounting The exposure is the net current assets exposure The all-current (closing rate) method: The accounting The exposure is the net assets or shareholders’ funds exposure The monetary/non-monetary method: The accounting The exposure is the net monetary assets exposure The temporal method: The accounting exposure varies The depending on the measurement method the subsidiary is used. The items that stated at replacement cost market value uses the closing rate method, other items that stated at historical cost uses historical rate. 6 Dr. Yinghong Chen Skövde University Economic Exposure Any anticipated changes in the exchange rates would have been already discounted and reflected in the firm’s value. Economic exposure can be defined as the extent to which the value of the firm would be affected by unanticipated changes in exchange rates. 7 Dr. Yinghong Chen Skövde University Economic exposure PV is present value of the foreign business in home currency value. CI is the estimated future incremental net cash inflow associated with the foreign business CO is estimated future incremental net cash outflow associated with the foreign business e is the expected future exchange rate r is the appropriate discount rate n PV = ∑ t =0 (CI −CO )e t (1 + r ) 8 Dr. Yinghong Chen Skövde University t t t Economic exposure Ex: assuming a Swedish company has wholly owned Danish firm with a NPV 120M DKK. The exchange rate is 1,2 Skr/Dkk. And subsequently moves to 1,3 Skr/Dkk. The value of the subsidiary has moved from Skr 144M to Skr 156M 9 Dr. Yinghong Chen Skövde University Chap 9: Financial accounting and Chap foreign exchange According to US accounting rules, translations of foreign currency denominated profit and loss accounts are to be made at the average exchange rate during the accounting period. The UK standard allows the use of either the current rate or the average rate for this purpose. It is fair to say that opinion in the United Kingdom is moving towards the average exchange rate method. 10 Dr. Yinghong Chen Skövde University Rules of financial accounting FAS 133 and IAS 39 Transaction gains, whether realized or not, are accounted for through the profit and loss account. But there is a major exception – and this relates to a foreign currency denominated borrowing. Where a transaction profit or loss, whether realized or not, arises from taking on a foreign currency borrowing in a situation in which the borrowing can be designated as a hedge for a net investment denominated in foreign currency, then the gain or loss on the borrowing, if it is less than the net investment hedged, would be accounted for by movements in reserves rather than through the income statement. If this kind of transaction gain or loss exceeds the amount of the loss or gain respectively on the net investment hedged, then the excess gain or loss is to be reported in the profit and loss account. 11 Dr. Yinghong Chen Skövde University ...
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This note was uploaded on 10/07/2011 for the course ACCOUNTING 4220 taught by Professor Brown during the Spring '11 term at UMBC.

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